Economics: The Functions of Money

1. What are the functions of money? (5) Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value, and occasionally, a standard of deferred payment. Money's most important function is as a medium of exchange to facilitate transactions. Without money, all transactions would have to be conducted by barter, which involves direct exchange of one good or service for another. The difficulty with a barter system is that in order to obtain a particular good or service from a supplier, one has to possess a good or service of equal value, which the supplier also desires. In other words, in a barter system, exchange can take place only if there is a double coincidence of wants between two transacting parties. Store of value. In order to be a medium of exchange, money must hold its value over time; that is, it must be a store of value. If money could not be stored for some period of time and still remain valuable in exchange, it would not solve the double coincidence of wants problem and therefore would not be adopted as a medium of exchange. 2. Explain why gold no longer performs the functions of money in the British economy? (5) The point of the gold-exchange standard is that it cannot last; the piper must eventually be paid, but only in a disastrous reaction to the lengthy inflationary boom. As sterling balances piled up in France, the U. S. , and elsewhere, the slightest loss of confidence in the increasingly shaky and jerry-built inflationary structure was bound to lead to general collapse. Thus the failure of inflated banks throughout Europe, and the attempt of hard money. France to cash in its sterling balances for gold, led Britain to go off the gold standard completely. Britain was soon followed by the other countries of Europe. The gold exchange standard was one of the elite collectivist bankers crowning accomplishments. But more coups were yet to come. In 1933 the bankers convinced Roosevelt to call in all private holdings of gold – essentially taking the money of the people. Gold was outlawed. Paper money was no longer redeemable in gold. This is why gold is not considered money in Britain. 3. Why are credit cards not money? (4) Money, in any form, is generally recognized as a very liquid asset, that is an asset that can be quickly converted to cash or used as cash Credit cards work in the same manner as a loan. If you buy an item using a credit card, the credit card company will pay the shopkeeper today and you will have an obligation to pay the credit card company when your credit card bill comes in. This obligation to the credit card company does not represent money. The money part of the transaction between you and the credit card company only comes into play when you pay your bill. So credit cards are not considered to be money. 4. Why is money in the current account of banks considered as money? (4) We have different types of accounts; savings accounts, current accounts and so on. But in this case, the bank rather takes the money you are supposed to receive as interest from you. That interest becomes a source of income to the bank. 5. What would you expect to happen to the rate of interest if money supply increases? Why? Draw a Diagram. (12) If money supply increases, the rate of interest will decrease. This is because the more money is available, the more loans are available. Competition for borrowers reduces the real interest rate. The NOMINAL interest rate may increase if the increase in the real money supply causes inflation. But in the short run, the interest rate falls, but as prices rise the interest rate will rise up again